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Akron Intellectual Property Journal
Akron Law Journals
March 2016
The Lawyer's Duty of Disclosure Ethics and
Sarbanes-Oxley the New Conundrum for Patent
Lawyers
Abraham C. Reich
Steven J. Rocci
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Recommended Citation
Reich, Abraham C. and Rocci, Steven J. (2007) "The Lawyer's Duty of Disclosure Ethics and Sarbanes-Oxley the
New Conundrum for Patent Lawyers," Akron Intellectual Property Journal: Vol. 1 : Iss. 1 , Article 3.
Available at: http://ideaexchange.uakron.edu/akronintellectualproperty/vol1/iss1/3
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Reich and Rocci: Sarbanes-Oxley and Patent Law
THE LAWYER'S DUTY OF DISCLOSURE ETHICS AND
SARBANES-OXLEY THE NEW CONUNDRUM FOR PATENT
LAWYERS
Abraham C. Reich & Steven J. Rocci
I.
INTRODUCTION
Lawyers who practice before the United States Patent and
Trademark Office ("PTO") understand the duty of disclosure. It is a
way of life in the ex-parte nature of those proceedings, commonly called
"patent prosecution." Indeed, Rule 56 of the patent code mandates that
material information of which a patent applicant, or his representative, is
aware, must be disclosed to the PTO during patent prosecution.'
Overlaying those obligations in the PTO are the lawyer's ethical
duties which are codified in the PTO Code of Professional
Responsibility.
Those responsibilities do not end at that point, as
various state ethical codes play into a lawyer's responsibility to disclose
information relating to the representation of a client in certain contexts
(either the Rules of Professional Conduct or the Code of Professional
Responsibility, depending upon the state where you are admitted to the
bar). What's more is that reconciling the ethics rules of the PTO and
those of the states can be challenging, at least when it comes to a
lawyer's obligations concerning the disclosure of client confidences.
If that were not enough, Congress saw fit add to the complex and
sometimes contradictory ethical obligations of the PTO code and state
bar ethics rules when it enacted the Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley"). 3 Enacted as a direct result of corporate scandals
starting with the Enron collapse in 2001, it ultimately targeted not only
corporate officials, but outside professionals as well - accountants and
1. See 37 C.F.R. § 1.56 (2006).
2. 37 C.F.R. § 10.1 ct seq. (2006)
3. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002).
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lawyers.4
Sarbanes-Oxley, by its express terms, only applies to lawyers "who
appear and practice" before the Securities and Exchange Commission.
So, do lawyers who practice only intellectual property law (even if they
practice only trademark or copyright law) need to worry? Do patent
lawyers who carefully limit their practice to the preparation and
prosecution of patent applications before the PTO need to worry about
Sarbanes-Oxley? Regrettably they do.
The general purpose of this paper is to sensitize intellectual
property lawyers to the potential impact on their practice created by
Sarbanes-Oxley. At a more detailed level, and because of the unique
challenges facing them, this paper addresses Sarbanes-Oxley's potential
impact on patent lawyers who practice before the PTO, even when it is
the patent lawyer's sole practice. To that end, this paper will highlight
relevant portions of Rule 56, the relevant ethical code sections, and the
pertinent considerations under Sarbanes-Oxley.
II. 37 CFR § 1.56 (RULE 56) - THE DUTY OF CANDOR AND GOOD
FAITH
Patents can be a potent weapon in a company's arsenal. Indeed, by
statute, a patent confers upon its owner the right to exclude others from
making, using, selling, offering for sale or importing the patented
invention.5 If someone violates this exclusivity, patent owners can
collect damages, sometimes equal to or in excess of its lost profits, for
acts of infringement.6 The nature of these benefits flows from the policy
underlining patents - to encourage innovation. 7 The federal courts are
made available to aggrieved patent owners 8 in order to give substance to
this policy. However, the quid pro quo of the right to exclude others is
that the patent owner must be entirely forthcoming with the PTO during
patent prosecution. 9 In this regard, section 1.56 of the PTO Rules
4. See generally JOHN T. BOSTELMAN, THE SARBANES-OXLEY DESKBOOK (Practicing Law
Institute) (2006). This two volume treatise is an excellent overview of the Act and the background
of its enactment.
5. 35 USC § 271(a) (2006).
6. 35 USC § 284 (2006).
7. U.S. Const. art. I, § 8, cl.8 ("The Congress shall have power... [to promote the progress
of Science").
8. 28 USC § 1331 (2006) (District Courts) & 28 USC § 1295 (2006) (The Court of Appeals
for the Federal Circuit).
9. See, e.g., Enzo Biochem, Inc. v. Gen-Probe Inc., 296 F.3d 1316, 1330 (Fed. Cir. 2002)
("[D]escription is the quid pro quo of the patent system; the public must receive meaningful
disclosure in exchange for being excluded from practicing the invention for a limited period of
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codified at 37 C.F.R. § 1.56 (2006), provides, in part:
Duty To Disclose Information Material To Patentability
(a) A patent by its very nature is affected with a public interest. The
public interest is best served, and the most effective patent examination
occurs when, at the time an application is being examined, the Office
is aware of and evaluates the teachings of all information material to
patentability.
Each individual associated with the filing and
prosecution of a patent application has a duty of candor and good faith
in dealing with the Office, which includes a duty to disclose to the
Office all information known to that individual to be material to
patentability as defined in this section[.]
III. THE LAWYER'S ETHICAL DUTY OF DISCLOSURE
A. The CurrentRules of Representationof Others Before the Patentand
Trademark Office (PTO Code)
The PTO Code has in place a.form of the Code of Professional
Responsibility' 0 which is codified in Part 10 of Title 37 of the Code of
Federal Regulations, 37 C.F.R. § 10.1 et seq. (2006)."1 Two relevant
portions follow:
(1) 37 C.F.R. § 10.56: Canon 4.
A practitioner should preserve the confidences and secrets of a client
(2) 37 C.F.R. § 10.57: Preservation of confidences and secrets of a
client
(a) "Confidences" refers to information protected by attorneyclient or agent-client privilege under applicable law. "Secret"
time.").
10. David Hricik, How Things Snowball: The Ethical Responsibilities and Liability Risks
Arisingfrom Representing a Single Client in Multiple Patent-RelatedRepresentations, 18 GEO. J.
LEGAL ETHICS 421, 424, 424 n. 19 (observing that the PTO code was directly inspired by the
American Bar Associations' Model Code of Professional Responsibility (1969), and as a result,
shares many parallel provisions with similar wording and effect).
11. Practice Before the Patent and Trademark Office, 50 Fed. Reg. 5158 (Feb. 6, 1985)
(formal notice of adoption).
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refers to other information gained in the professional relationship
that the client has requested be held inviolate or the disclosure of
which would be embarrassing or would be likely to be detrimental
to the client.
(b) Except when permitted under paragraph (c) of this section, a
practitioner shall not knowingly:
(1) Reveal a confidence or secret of a client.
(2) Use a confidence or secret of a client to the disadvantage
of the client.
(3) Use a confidence or secret of a client for the advantage of
the practitioner or of a third person, unless the client consents
after full disclosure.
(c) A practitioner may reveal:
(1) Confidences of secrets with the consent of the client
affected but only after a full disclosure to the client.
(2) Confidences or secrets when permitted under Disciplinary
Rules or required by law or court order.
(3) The intention of a client to commit a crime and the
information necessary to prevent the crime.
(4) Confidences or secrets necessary to establish or collect
the practitioner's fee or to defend the practitioner or the
practitioner's employees or associates against an accusation
of wrongful conduct.
(d) A practitioner shall exercise reasonable care to prevent the
practitioner's employees, associates, and others whose services are
utilized by the practitioner from disclosing or using confidences or
secrets of a client, except that a practitioner may reveal the
information allowed by paragraph (c) of this section through an
employee.
B. ProposedAmendments To The PTO Code
On December
12, 2003,
the Federal
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SARBANES-OXLEY AND PATENT LAW
comment proposed amendments to the ethical guidelines for those
representing others before the PTO.12 The change contemplates a shift
from a "Code" format to a "Rules" format.13 These proposed changes
followed several years of debate by the American Bar Association
House of Delegates over changes to Model Rules of Professional
Conduct. Thereafter, on March 3, 2004, the PTO requested public
comment on a number of the proposed rules. 14 While no public
announcement has been made as to when the new rules will be enacted,
it is likely that by the end of 2007, patent practitioners will have a new
set of ethical guides in the PTO.
Two of the proposed rules are worth noting.
15
(1) § 11.106: Confidentiality of information
(a) A practitioner, in regard to practice before the Office, shall
not:
(1) Reveal information relating to representation of a client
unless the client gives informed consent in writing after full
disclosure by the practitioner, except for disclosures that are
impliedly authorized in order to carry out the representation,
and except as stated in paragraphs (b), (c), or (d) of this
section:
(2) Knowingly use information relating to representation of a
client to the disadvantage of the client; or
(3) Use a confidence or secret of the practitioner's client for
the advantage of the practitioner or of a third person.
(b) A practitioner, in regard to practice before the Office, may
reveal such information to the extent the practitioner reasonably
believes necessary:
(1) To prevent the client from committing a criminal act that
the practitioner believes is likely to result in imminent death
or substantial bodily harm; or
12. Changes to Representation of Others Before the United States Patent and Trademark
Office, 68 Fed. Reg. 69442 (Dec. 12, 2003).
13. Id. (Summary).
14. Changes to Representation of Others Before the United States Patent and Trademark
Office, 69 Fed. Reg. 9986 (Mar. 3, 2004).
15. Id.; Cf Model Rules of Prof I Conduct R. 1.6 (1983).
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(2)
To establish a claim or defense on behalf of the
practitioner in a controversy between the practitioner and the
client, to establish a defense to a criminal charge or civil
claim against the practitioner based upon conduct in which
the client was involved, or to respond to allegations in any
proceeding concerning the practitioner's representation of a
client.
(c) A practitioner, in regard to practice before the Office, shall use
or reveal information relating to representation of a client to
comply with the provisions of § 1.56 of this subchapter in practice
before the Office in patent matters (see 11.303(d));
(d) A practitioner, in regard to practice before the Office may use
or reveal information relating to representation of a client to
comply:
(1) With the informed consent in writing of the client
affected, but only after full disclosure by the practitioner to
the client;
(2) With rules, law or court order when permitted by these
rules or required by law or court order; or
(3) With the law or regulations of the Office, when permitted
or authorized by the law or regulations, in connection with
representation before the Office, whether or not the
practitioner is employed by the Federal Government.
(e)
The client of practitioner employed by the Federal
Government is the Department, agency or commission that
employs the practitioner unless appropriate law, regulation, or
order expressly provides to the contrary.
(f) A practitioner shall exercise reasonable care to prevent the
practitioner's employees, associates, and other whose services are
utilized by the practitioner from disclosing or using such
information of a client, except that such persons may reveal
information permitted to be disclosed by paragraphs (c), (d), or (e)
of this section.
(g) The practitioner's obligation to preserve in confidence such
information continues after termination of the practitioner's
employment, except as provide for in § 1.56.
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SARBANES-OXLEY AND PATENT LAW
(h) The obligation of a practitioner under paragraph (a) of this
section also applies to such information learned prior to becoming
a practitioner in the course of providing assistance to another
practitioner.
The irony with the proposed amendment is that it allows less of an
opportunity for lawyers to disclose wrongdoing by their clients. Section
11.106(b)(1) only allows a lawyer to disclose "a criminal act", which the
lawyer believes "is likely to result in imminent death or substantial
bodily harm". The American Bar Association amended the version of
this rule by allowing lawyers to disclose information "to prevent
reasonably certain death or substantial bodily harm" and the intention of
a client to commit a crime likely to result in "substantial injury to the
financial interests or property of another". Moreover, the existing Rule
in the PTO, allows a lawyer to reveal the intention of a client to commit
a crime - any crime! When the new rules are finally enacted (by year
end 2007) it will not be surprising to see a change in this rule which will
allow a practitioner to disclose a crime involving harm to the financial
interests of another. It would certainly be more in line with the national
standard.
16
(2) § 11.113 Organization As Client
(a) A practitioner employed or retained by an organization
represents the organization, which acts through its duly authorized
constituents.
(b) If a practitioner employed or retained by an organization
having immediate or prospective business before the Office knows
that an officer, employee or other person associated with the
organization is engaged in action, intends to act or refuses to act in
a matter related to the representation that is a violation of a legal
obligation to the organization, or a violation of law which
reasonably might be imputed to the organization, and is likely to
result in substantial injury to the organization, the practitioner
shall proceed as is reasonably necessary in the best interest of the
organization. In determining how to proceed, the practitioner shall
give due consideration to the seriousness of the violation and its
consequences, the scope and nature of the practitioner's
representation, the responsibility to the organization and the
apparent motivation of the person involved, the policies of the
16. Id.; C.f Model Rules of Prof l Conduct R. 1.13 (1983).
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organization concerning such matters and any other relevant
considerations.
Any measures taken shall be designed to
minimize disruption of the organization and the risk of revealing
information relating to the representation to persons outside the
organization. Such measures may include among others:
(1) Asking reconsideration of the matter;
(2) Advising that a separate legal opinion on the matter be
sought for presentation to appropriate authority in the
organization; and
(3)
Referring the matter to higher authority in the
organization, including, if warranted by the seriousness of the
matter, referral to the highest authority that can act in behalf
of the organization as determined by applicable law.
(c) If, despite the practitioner's efforts in accordance with
paragraph (b) of this section, the highest authority that can act on
behalf of the organization insists upon acting, or a refusal to act,
that is clearly a violation of law and is likely to result in
substantial injury to the organization, the practitioner may resign
in accordance with § 11.116.
(d)
In dealing with an organization's directors, officers,
employees, members, shareholders, or other constituents, a
practitioner shall explain the identity of the client when it is
apparent that the organization's interests may be adverse to those
of the constituents with whom the practitioner is dealing.
(e) A practitioner representing an organization may also represent
any of its directors, officers, employees, members, shareholders,
or other constituents, subject to the provisions of § 11.107. If the
organization's consent to the dual representation is required by
§ 11.107, the consent shall be confirmed in writing by an
appropriate official of the organization other than the individual
who is to be represented, or by the shareholders.
The amendment reflects the traditional opportunity to "report up" the
corporate hierarchy. If blowing the whistle on wrongdoing proves
unsuccessful, the lawyer may resign. As will be elaborated, SarbanesOxley gives the lawyer greater latitude - and a higher mandate - to stop
the wrongdoing.
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SARBANES-OXLEY AND PATENT LAW
IV. SARBANES-OXLEY'S IMPACT ON LAWYERS' DUTY OF DiSCLOSURE
In August 2001, Enron Corporation's downfall began when its
CEO Jeffrey Skilling resigned. By December of that year, Enron filed
for reorganization with Chapter 11 of the U.S. Bankruptcy Code. The
uproar over the Enron debacle was only fueled by a series of corporate
scandals all within one year.' 7 Arthur Anderson LLP, Enron's auditors,
admitted to destroying documents during its Enron engagement, leading
to its criminal conviction and collapse. Further post-Enron scandals
included financial frauds and accounting restatements at Global
Crossings, Adelphia and Tyco. Therefore, it is not surprising that
Congress enacted the Sarbanes-Oxley Act of 2002 (the "Act" or
"Sarbanes-Oxley"). 18 The clear goal of the legislation, was to make
financial reporting by public companies more reliable and to hold the
management responsible to insure the same. As a safety net, the
legislation was broadened to include the outside professionals for such
companies - namely its accountants and lawyers.19
In Section 307 of the Sarbanes-Oxley Act of 2002, Congress
directed the Securities and Exchange Commission (the "SEC" or
"Commission") to issue rules establishing standards of professional
conduct for attorneys who appear and practice before the Commission
on behalf of public companies, including a rule requiring attorneys to
report "up-the-ladder" evidence of material violations of securities law,
breaches of fiduciary duty or similar violations. Section 307 stated:
Not later than 180 days after the date of enactment of this Act, the
Commission shall issue rules, in the public interest and for the
protection of investors, setting forth minimum standards of
professional conduct for attorneys appearing and practicing before the
Commission in any way in the representation of issuers, including a
rule(1)requiring an attorney to report evidence of a material violation
17. "Within a short period of time, Adelphia Communications Corp.,Global Crossing Ltd.,
ImClone Systems, Merck & Co., Qwest Communications, Rite Aid Corp., Tyco International Ltd.,
WorldCom Inc., and Xerox were all accused of accounting improprieties. The accounting practices
of other companies[, even] AOL Time Warner [and] General Electric became a topic of everyday
conversation ... Reconsideration of recent years' accounting restatements, particularly those
inspired by SEC enforcement actions-suppressed memories of Cedant, MicroStrategy, Sunbeam,
Waste Management and others-revealed the ubiquity of what had until recently looked like isolated
incidents of accounting fraud." David Westerbrook, CorporationLaw After Enron: The Possibility
of a CapitalistReimagination, 92 GEO. L.J. 61, 65-67 (2003).
18. See supra note 3.
19. Id.
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AKRON INTELLECTUAL PROPERTY JOURNAL
of securities law or breach of fiduciary duty or similar violation by
the company or any agent thereof to the chief legal counsel or the
chief executive officer of the company (or the equivalent thereof);
and
(2)if the counsel or officer does not appropriately respond to the
evidence (adopting, as necessary, appropriate remedial measures
or sanctions with respect to the violation), requiring the attorney to
report the evidence to the audit committee of the board of directors
of the issuer or to another committee of the board of directors
comprised solely of directors not employed directly or indirectly
by the issuer, or to the board of directors.
On November 21, 2002, the Commission published for comment
proposed rules entitled "Standards of Professional Conduct for Attorneys
Appearing and Practicing before the Commission in the Representation
of an Issuer" (the "Attorney Regulations"). 2' Not surprisingly, the
proposed Attorney Regulations sparked reactions from all segments of
the securities law bar.22
After considering the comments, the
Commission adopted final versions of the Attorney Regulations, which
became effective August 5, 2003,23 and are codified at 17 C.F.R. Part
205 .24
20. Id.; Codified at 15 U.S.C. § 7245 (2006).
21. Release 33-8150 (Nov. 21, 2002); 2002 SEC LEXIS 3004 (Nov. 21. 2002).
22. See, e.g., Implementation of Standards of Professional Conduct for Attorneys, 68 Fed.
Reg. 6296 (Feb. 6, 2003) (noting a "total of 167 timely comment letters: 123 from domestic parties
and 44 from foreign parties" to the official request for comments).
23. Id.
24. 17 CFR §§ 205.1-205.7 (2006). Of course, the lawyer's role cannot be considered in
isolation, as the key leaders of a public company have specific duties under the Sarbanes-Oxley Act.
The key provisions of Sarbanes-Oxley include:
Section 302 - CEOs and CFOs must certify the accuracy of financial information fairly presenting "in all material respects" the company's financial condition.
Section 401 - Reports prepared in accordance with GAAP shall reflect all material
correcting adjustments identified by the accountant.
Section 404 - Must document and certify the internal financial reporting procedures and
controls.
Section 409 - Must deliver real-time reports of "material events" affecting company to
shareholders or other "stakeholders."
Section 906 - CEO's and CFO's must also certify that the financial statements comply
with Section 13(a) and 15(d) of the Securities Exchange Act of 1934 and that the
information presents "in all material respects" the financial condition and operation of
the issuer.
The certifications take on significance, as recent federal court opinions demonstrates. See In re:
Lattice Semiconductor Corporate Securities Litigation, 2006 WL 538756 (D. Or. 2006) (The
Sarbanes-Oxley certifications give rise to an inference of "scienter" under the securities laws);
Limantour v. Cray, Inc., 432 F.Supp.2d 1129 (W.D. Wash. 2006) (Complaint adequately stated that
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Under the Attorney Regulations, an attorney must act reasonably in
deciding whether there is credible evidence of a material violation, even
if the attorney does not yet "know" with certainty whether a violation
has occurred. Ultimately, if the attorney concludes that it is "reasonably
likely" that a material violation has occurred, is ongoing or is about to
occur, he or she must report. The "reasonably likely" standard means
that a violation is "more than a mere possibility," but does not require
the violation to be "more likely than not., 25 It is important to note that
there is no requirement that the material violation be in any way related
to the representation being undertaken by the attorney.
A "material violation" for the purposes of the Attorney Regulations
"means a material violation of an applicable federal or state securities
law, a material breach of fiduciary duty arising under United States
federal or state law, or a similar material violation of any United States
federal or state law." 26 The Attorney Regulations do not define the term
"material." The phrase "breach of fiduciary duty" is broadly defined as
"any breach of fiduciary or similar duty to the issuer recognized under
an applicable federal or state statute or at common law, including but not
limited to misfeasance, nonfeasance, abdication of duty, abuse of trust,
and approval of unlawful transactions."2 7
Determining whether a material violation has occurred in the
context of intellectual property ("IP") is an especially daunting task
primarily because of the inherent difficulty in assigning value to
intangible assets. Furthermore, some IP is not registered, and as a result,
some companies may not be aware of their rights, or the full scope of
their rights, to various copyrights and trademarks. Therefore, companies
should assess what IP they have, how they monitor it, how they report it,
and whether their existing procedures are going to meet the new
standards under Sarbanes-Oxley. The challenges with respect to patents
and patent applications are particularly acute because of the vast swing
of values which may be attributable to them - impacted by conduct in
Forms I0-Q and Sarbanes-Oxley certifications were false or misleading, for purposed of investor's
claim of fraud under federal securities law); But see Garfield v. HDC Health Corp., et al, 2006 WL
2883238 (1 1th Cir. 2006) (Officers signed personal certification of corporation's financial statement
as required by Sarbanes-Oxley Act, were insufficient to satisfy particularity requirement to plead
scienter in securities fraud action against corporation); Zucco Partners, LLC v. Digimarc Corp.,
2006 WL 2252557 (D. Or. 2006) (Allegations of scienter based on statements of six confidential
witnesses, Sarbanes-Oxley certifications and sales of issuer's stock by the individual defendants
during the class period were insufficient to satisfy pleading requirements of PSLRA).
25. Implementation of Standards of Professional Conduct for Attorney, 68 Fed. Reg. 6296,
§205(e) n. 47 (Feb. 6, 2003).
26. 17 C.F.R § 205.2(i).
27. Id.
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the PTO or the marketplace.
V. THE IMPACT OF SARBANES-OXLEY ON IP LAWYERS
The reach of the Attorney Regulations is vast. Although they do
not specifically mention intangible assets directly, the2 8 Attorney
Regulations certainly encompass intellectual property as well.
With IP now comprising substantial portions of corporate assets,
many public companies recognize the potential impact of the Act on this
increasingly important area in corporate controls and disclosures. 9
While some companies are taking the initiative to begin updating
their
30
IP processes, others are cautiously awaiting further direction.
The Attorney Regulations apply to lawyers "appearing and
practicing" before the SEC on behalf of issuers of publicly-traded
securities, including both in-house and outside counsel. The phrase
"appearing and practicing" before the SEC includes:
(i) transacting any business with the Commission, including any form
of communication;
(ii) representing a public company in any Commission administrative
proceeding or in connection with any Commission investigation,
inquiry, information request or subpoena;
(iii) providing advice about the United States securities laws or the
Commission's rules or regulations thereunder regarding any document
that the attorney has notice will be filed with or submitted to, or
incorporated into any document that will be filed with or submitted to,
the Commission, including providing such advice in the context of
preparing, or participating in the preparation of, any such document; or
(iv) advising a public company as to whether certain information or a
statement, opinion or other writing is required under United States
securities laws or SEC regulations thereunder to be filed with or
submitted to, or incorporated into any document that will be filed with
28.
Alison Carpenter, Sarbanes-Oxley Compliance: Don't Forget IP Valuation, BNA
INTERNATIONAL:
WORLD
AND
TAX
LAW
REPORT,
Apr.
http://newsweaver.co.uk/bnainternational/e_articleOO0386710.cfm.
18,
2005,
available
at
See also, Ira L. Kotel The Role
of the IP Lawyer in Compliance with the Sarbanes-Oxley Act, 22 THE COMPUTER AND INTERNET
LAWYER 8 (August 2005).
29. Carpenter, supra note 28.
30. Id.
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or submitted to, the Commission.
31
Under the Attorney Regulations, even an IP attorney who does not
regularly practice securities law may be deemed to be appearing and
practicing before the SEC if he or she drafts, negotiates or otherwise
gives advice with respect to any document that he or she has prior notice
will be filed by, or incorporated into a document filed by, a public
company with the Commission. For example, if an IP lawyer represents
a public company in a transaction that must be reported, such as a
critical licensing or other intellectual property agreement, the documents
related to the reportable transaction must be filed with the Commission
or integrated into such a filing. Responses to audit inquiries from
accountants for public companies may also come into play. The mere
fact that the IP lawyer knows that the documents will be filed with the
SEC by the public company, may make him or her liable under the
Attorney Regulations because he or she will be deemed to be "appearing
and practicing" before the Commission.32 Similarly, a "supervisory
attorney," such as a partner or senior associate, also is deemed to appear
and practice" before the Commission if he or she directly oversees a
subordinate attorney who is appearing and practicing before the
Commission.3 3
Attorneys acting other than in the context of providing legal
services to a public company with which the attorney has an attorneyclient relationship are not deemed to be "appearing and practicing"
before the Commission,34 nor are most foreign attorneys.3 5
A. What Must Be Reported
If a lawyer appearing and practicing before the SEC becomes aware
of "evidence of a material violation" by the public company or by any of
its "officer[s], director[s], employee[s] or agent[s]," .36 the Attorney
Regulations mandate that the attorney report the evidence of a material
violation to the company in an up-the-ladder method.37 This is similar in
38
some"Evidence
respects with
1.13 ofviolation"
the Rules of
Conduct. based
of Rule
a material
is Professional
"credible evidence,
31.
32.
33.
34.
35.
17 C.F.R. §§ 205.2(a)(1)(i) - 2(a)(1)(iv).
Kotel, supra note 28, at 17-18.
17 C.F.R. § 205.4(a).
17 C.F.R. § 205.2(a)(2)(i).
17 C.F.R. § 205.2(a)(2)(ii).
36.
17 C.F.R. § 205.3(b)(1).
37.
38.
See 17 C.F.R. § 205.3(b).
Model Rules of Prof'l Conduct R. 1.13 (1983).
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upon which it would be unreasonable, under the circumstances, for a
prudent and competent attorney not to conclude that it is reasonably
likely that a material violation has occurred, is ongoing or is about to
occur." 39 The SEC intends this to be an objective standard. 40 However,
the degree of knowledge and diligence satisfying the "reasonable
prudence" test in the context of a company's IP portfolio is nebulous, at
best. Each situation turns on its own unique set of facts and
circumstances where the more IP means to a business, the more
important it is for companies to protect their IP assets.
Experts interviewed for an article in World Tax and Report4"
suggest that companies:
"
Familiarize CEOs and CFOs with the IP portfolios so they can
make accurate and informed certifications;
*
Keep board members and other corporate players informed;
*
Involve IP counsel in overall IP management; and,
*
42
Implement an effective IP Asset Management Plan.
Each of these tasks will be examined in greater detail.
B. FamiliarizeCEOs And CFOs With The IP PortfoliosSo They Can
Make Their Certifications
Under Sections 302 and 906, CEOs and CFOs are required to
personally certify that the information disclosed in corporate reports
accurately represents the financial conditions of their companies.4 3
Under Sarbanes-Oxley, these officers are responsible for the execution
and maintenance of the required "disclosure controls and procedures."
These disclosure controls and procedures must be fashioned to make
certain that essential material information is documented, reviewed,
understood and reported to the appropriate corporate officials in order to
accurately disclose material.
39. 17 C.F.R. § 205(e).
40. Implementation of Standards of Professional Conduct for Attorneys, 68 Fed. Reg. 6296
(Feb. 6, 2003) ("[T]he triggering standard for reporting evidence of a material violation has been
modified to clarify and confirm that an attorney's actions will be evaluated against an objective
standard.").
41. Carpenter, supra note 28.
42. Id.
43. See supra note 24.
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Accomplishing these goals can be an arduous task in the IP context
because IP by its very nature is intangible and difficult to conceptualize.
The valuation of IP necessary to make accurate disclosures depends on a
plethora of events and circumstances that may or may not occur, which
makes forecasting the future value of an IP right complex. However the
slightest change in a given market can have monumental consequences
in the realm of IP. For example, a patent issuing from an application
filed years ago may suddenly become more valuable today because a
technology "fad" took years to mature. The same patent may suddenly
become worthless two years hence because a minor design around may
lead to unabated competition.
The Act is devoid of any mention of "intangible assets," but with IP
making up a large part of many companies' assets, it is obvious why it is
prudent to familiarize CEOs, CFOs and other senior officers with the
company's overall IP portfolio. CEOs and CFOs charged with the task
of certifying corporate disclosures must have, at least a cursory, yet
working understanding of its company's IP portfolio. This includes
understanding "how new IP is developed and identified; [knowing] what
claims have been raised and alleged infringements; [knowing] an IP
portfolio's value; and being aware of enforcement actions brought by the
company against third parties; and third party claims brought againstthe
company."4 Ultimately the key to ensuring that CEOs and CFOs can
make accurate certifications is to familiarize them with the company's
overall IP portfolio.4 5
C. Keep Board Members And OtherPlayers Informed
A fundamental, but sometimes over-looked component of the
Sarbanes-Oxley Act is how it has increased the need for all major
corporate players in public companies to take an active role in the
control of the company's IP.46 The experience of in-house patent
counsel and even outside counsel notwithstanding, it is important to
approach the challenges of IP evaluation from a holistic perspective.4 7
Experts underscore the prudence of involving other members of the
management team from leaders in marketing and engineering, to
research and development, and finance in the strategic decision making
44. Carpenter, supra note 28 (quoting Cydney A. Tune, an IP attorney with Pillsbury
Winthrop LLP in San Francisco, CA).
45. Id.
46. James DeCarlo, The Board's Responsibilitiesfor Intellectual Property Management, THE
CORPORATE GOVERNANCE ADVISOR, Jan.-Feb. 2005, at 9.
47. See ld, at 7.
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regarding IP assets. This ensures that any IP decision can be evaluated
taking into consideration its impact on the business as a whole.48
For instance, as James DeCarlo points out in his article The Board's
Responsibilitiesfor IP Management,49 patent counsel may be unaware of
significant market plans for the company that may have a bearing on
where a patent should be filed, whether existing patents should be
researched, or whether new patents should be registered. ° Without
feedback from other members of management, patent counsel may miss
an opportunity to seek patent protection in a market, exposing the
company to potential liability that may result in financial losses.5'
Another group integral to making accurate IP disclosures is a
company's board of directors. One question currently unanswered and
facing directors is whether they can be held personally responsible for
damages resulting from insufficient IP portfolio management.5 2 In a
2001 case of first impression, In Re RSA,53 a group of investors brought
a shareholder's derivative suit against RSA Security, Inc. (RSA). The
investors alleged that the directors had breached their duty of care by
neglecting to file for and obtain European patent protection for RSA's
core patents.54 The directors' negligence, according to the shareholders,
harmed RSA's stock price constituting because RSA competitors were
using RSA's intellectual property without compensation to RSA.55 They
maintain that this constituted a breach of fiduciary duty. The case left
little to be gleaned
in the form of precedent by ending with a seven56
figure settlement.
Traditionally, the ostensible "business judgment rule" has
prevented such suits against management for their professional decisions
where the questionable action was taken with "due care." 57 Just as
standards of conduct change as evidenced by the obligations imposed
under Sarbanes-Oxley, however, so has the definition of "due care.', 58 A
Delaware court has declined to extend the business judgment rule to
claims arising from a director's inaction absent a conscious decision not
48. Id. at 8.
49. Id.at 9.
50. Id.
51.
Id.
52. DeCarlo, supra note 46, at 7.
53. Id.. Also see In Re RSA Security, Consolidated Civil Action No. 18 107-NC (Del. Ch.
Filed June 15, 2000), availableat http://www.legalcasedocs.com/120/240/278.html.
54. DeCarlo, supra note 46, at 7.
55. Id.
56. Id.
57. Idat 7-8.
58. Id.at 8.
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to act. 59
Under this court's reasoning, it may still be prudent for
directors and officers to delegate responsibilities regarding the
management of a company's intellectual property, but they should do so
only after60 meticulous investigation and communications with IP
attorneys.
D. Involve IP Counsel In The Management OffP
Upper management and directors must involve IP attorneys in all
matters even remotely relevant to IP. Though a seemingly basic notion,
IP management plans which are devoid of IP attorney support may leave
corporate players uninformed regarding IP litigation or the threat of IP
litigation affecting the rights of the company.
The existence of material risks relating to the use and protection of
a company's IP assets may require disclosure in the risk factors section
of the report. A knowledgeable IP attorney may be the only corporate
members who can foresee such risks.6 1
Furthermore, material litigation regarding a company's assets must
be disclosed in the legal matters section.62A failure to adequately
disclose any of these threats may violate Sarbanes-Oxley. Of course, IP
attorneys are best positioned to analyze the relevant information needed
to make informed decisions in response to legal threats to a company's
IP portfolio.63
For example, as is common when a company is alleged to have
committed patent infringement, the company may secure outside counsel
to conduct an independent infringement and validity study on the
asserted patents. IP disputes may result in injunctions that would
materially harm the company and might involve substantial damages
(e.g., the threatened injunction in the NTP v. RIM litigation over the
ubiquitous "Blackberry"). Therefore, CEOs and CFOs must be aware of
potential litigation relating to material IP rights of the company. IP
attorneys are often the most capable of drawing legal conclusions and
offering legal advice in this context and should be involved in all facets
of IP management.
59. Pereira v. Gogan, 2003 WL 21039976 (S.D.N.Y. 2003).
60. Id.
61. See DeCarlo, supra note 46, at 9.
62. Kotel, supra note 28, at 15.
63.
Id. at 16-17 (listing possible factors to consider).
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E. Implement An IP Asset Management Plan
The goal of any company's approach to ensuring compliance with
the Sarbanes-Oxley Act is to implement an IP asset management plan or
revise an existing plan to make it more effective In his article The
Board's Responsibilitiesfor IP Management, James DeCarlo suggests
that IP attorneys and corporate heavyweights should address the
following issues in an effective IP asset management plan:
(1) What the company's IP assets are;
(2) How they are valued;
(3) What role IP plays in the company's core business and in the
market in which it competes;
(4) Which IP assets are most critical to the company and whether they
are adequately protected;
(5) How newly created IP assets of the company are being identified
and protected currently;
(6) What areas of the company need more (or less) IP support; and,
64
(7) The IP position of the company's principal competitors.
This commentator cautions that this list is not exhaustive and should be
tailored to reflect the specific IP needs of the individual company. 65 The
first step in developing an IP asset management program is to conduct an
IP audit to identify current IP. 66 DeCarolo warns that a mere list of
patent numbers, though a firm foundation, is not a comprehensive IP
inventory. 67 He recommends that an effective IP inventory include
"both pending and issued patents, trademarks, trade secrets, copyrights,
inventions that have not yet been protected, and
license agreements that
68
govern out-licensed or in-licensed technology.,
The next step is to assign value to this sometimes extensive
portfolio of intangible assets.
Herein lies a complex challenge.
Traditionally those involved in the valuation of IP have been IT
64.
65.
66.
67.
68.
DeCarlo, supranote 46, at 10.
Id.
Id.
Id.
Id.
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personnel who do not have an "IP-centric focus which is very dangerous
because GAAP [generally accepted accounting principles] does not pick
up IP well., 69 To extrapolate the general worth of non-liquid assets,
companies have to develop a system where they can "make assets more
liquid., 70 Traditional valuation processes are virtually useless in the IP
domain because the value of IP differs in "not only in time, but also in
geography, [and] in what domain space" the company operates.7 1
Experts suggest beginning the valuation process by evaluating areas
such as mergers and acquisitions where there are already guidelines in
place. Ultimately, companies must engage in "abstract thinking" in this
area of financial
reporting that is "fraught with judgment and
72
subjectivity.
After cataloguing and assigning value to the inventory of IP, a
company can begin to develop a formal, comprehensive IP management
plan. The key to success, according to experts, is to understand where
the intangible assets are from research and development through
commercialization because then certain risk factors can be applied to
ascertain a sensible value.73
VI. SARBANES-OXLEY AND THE PATENT LAWYER
So, what does Sarbanes-Oxley mean to the patent lawyer who
prosecutes patent applications? Does such a lawyer have any reporting
obligation under Sarbanes-Oxley?
Consider a fledgling public company whose entire business has
been built around a blockbuster drug invented by one of its founders.
Key claims of the company's patent application on the drug have been
allowed by the PTO. However, prosecution of the application remains
open in the PTO for other reasons. In any event, the news that the
Company will likely obtain the key claims triples the value of the stock.
Soon after this news, and while the application is still pending, patent
counsel learns about a publication that is clearly material to patentability
if it is prior art. Patent counsel has formed a reasonable judgment that,
based on the available information, the reference likely does not satisfy
the legal standards for prior art, but that, to satisfy Rule 56, he should
69.
Carpenter, supra note 28 (quoting Robert J. Block, managing director of a Chicago-based
risk management firm).
70. Id.(quoting Robert J. Block).
71. Id.(quoting Nancy Drehwing Edwards, a director at ipCapital Group Inc. in Williston,
Vermont).
72. Id.(quoting Karen Kincaid Balmer, a partner with Kincaid Consulting LLC in New York)
73. DeCarlo, supra note 46, at 8.
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disclose all of this to the PTO. He also believes that there is a 40%
chance that the PTO will disagree with him. He tells all of this to his
immediate supervisor, who has a significant investment in the stock of
the company. His supervisor instructs him not to disclose the reference.
Does patent counsel have an obligation to report up the ladder? Is
failure to report up the ladder a "material violation" of Sarbanes-Oxley?
The possibilities are endless. Suppose outside counsel renders an
unfavorable opinion regarding a third party blocking patent to the inhouse counsel of his client's company. The subject matter of the
opinion is such that, if, in litigation, the third party patent were to be
found to be infringed by the company, the company's stock would
plummet. Outside counsel learns that his opinion has not been reported
to company management. Does outside counsel have any obligation to
go around in-house counsel and report up the ladder? Tangential, yet
highly important issues of patent valuation and worth, and findings
during due diligence, are additionally raised by these hypothetical
scenarios.
In the end, resolution of the issue comes down to the "materiality"
of the information under the (as yet undefined) Sarbanes-Oxley standard.
Compliance with the PTO standard of materiality, or even the PTO or
state rules of professional conduct, might not suffice.
VII. CONCLUSION
We are facing uncharted waters on the lawyer's duty of disclosure,
particularly as amplified by Sarbanes-Oxley. Presently there is little
guidance as to the direct impact Sarbanes-Oxley has on IP. 74 However,
with its broad-sweeping guidelines and in light of large corporate
scandals centered around inaccurate disclosures, the Act is sure to have
74. To date, other than the opinions cited in supra note 24, the reported opinions on SarbanesOxley involve questions of statute of limitations, private rights of actions, the extraterritorial
application of the Act and the arbitrability of claims under it. See, e.g., Camero v. Boston Scientific
Corp., 433 F.3d (1st Cir. 2006) (Whistleblower protection provision of Sarbanes -Oxley Act did not
have extraterritorial application to extend protection to foreign employee working abroad for
foreign subsidiary); Lieberman v. Cambridge Partners, LLC, 432 F3d 482 (3rd Cir. 2005) (Sarbanes
Oxley Act's extension of applicable limitations period for private securities fraud claims did not
apply retroactively to revive claims already extinguished by the statute of repose before enactment
of the extension); Neer v. Pelino, 389 F.Supp.2d 648 (E.D. PA. 2005) (Sarbanes-Oxley Act
provision allowing for disgorgement of bonuses and profits by corporate offices did not create a
private right of action); In re: Digimarc Corp. Derivative Litigation, 2006 WL 2345497 (D. Or.
2006) (Lack of standing on grounds that there is no private cause of action for a violation of Section
304 of Sarbanes-Oxley); Alliance Bernstein Inv. Research and Management, Inc. v. Schaffran, 445
F.3d 121 (2nd Cir. 2006) (Sarbanes-Oxley claims subject to arbitration).
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63
an impact on IP. To ensure a higher likelihood of compliance with the
Attorney Regulations in the Act, companies must familiarize CEOs and
CFOs with the IP portfolios so they can make accurate and informed
certifications; keep board members and other corporate players
informed; involve IP counsel in overall IP management; and, implement
an effective IP Asset Management Plan.
In light of the serious
consequences of violating Sarbanes-Oxley (i.e. criminal penalties), to do
less may prove to be imprudent.
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